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Economy in Brief

Is America on the Losing End on Trade With China?
by Joseph G. Carson ([email protected])  May 15, 2019

The Trump Administration has argued that China's unfair trade practices, which include tariffs, non-tariff barriers, export and financial subsidies, limit market access for imported goods, and investment restrictions are largely responsible for the large trade imbalance between the two countries.

Except for Hong Kong, which is essentially a trading arm of the China export machine, the US trade deficit with China is larger than the total of the next 10 countries that run deficits with China. Also, the US ranks as the second largest manufacturer in the world, just behind China, and ahead of Germany and Japan. Yet, Germany and Japan, which also operate global supply chains inside China like the US, generate trade surpluses with China, while the US records a large deficit.

So what makes the US and China trade relationship unique? China's unfair and abusive trade practices hit all countries equally hard so why is it that the US is the one country that experiences that largest trade imbalance with China?

One possible explanation is that US companies have used China much more aggressively to expand its global manufacturing platform, create global supply chains, lower its costs structure (especially labor costs) and source cheaper products and materials to better enable them to generate profits and maximize shareholder value.

In 2000, the US voted to start normal trade relations with China, which paved the way for China to join the World Trade Organization. Granting China permanent trade status gave US companies the confidence that they could start sourcing materials and supplies from Chinese suppliers, as well as transfer production offshore, without fearing any punishment or penalties from the US government.

In the past two decades, US companies have invested nearly $1 trillion in the Chinese economy, and today those affiliates generate over $350 billion in sales, making China the third largest offshore sales operation, only behind Singapore and Ireland.

In terms of employment, US affiliates in China employ 1.7 million workers, representing the largest off-shore workforce of US multinational companies, exceeding the workforce of Mexico and Canada, two countries where US firms operate large manufacturing operations, and even the UK, where for decades a diverse group of US firms has run a wide range of legal and financial activities.

The trade flows between the US and China show the unbalanced pattern that the Trump Administration wants to reverse. In 2018, imports of merchandise goods from China totaled $540 billion, whereas exports to China totaled $121 billion, resulting in a trade deficit of $419 billion, the largest on record.

Yet, the one shortcomings of foreign trade data it is based on the country of origin and not the country of its owner. At one point, it was estimated that more than half of the goods imported from China were made by US companies off-shoring their production in China. And, a large part of the remaining imports was due to US firms sourcing their products from China. Today, the four largest US importers from China are Wal-Mart, Target, Home Depot and Lowe's, all consumer goods companies.

It is hard to ascertain the scale of US global profits being generated from operations or sourcing arrangements in China. Yet, the boost to overall profitability US firms have gotten from China and other off-shoring activities has been huge. In 2018, US corporate earnings from overseas affiliates accounted for 45% of total profits, and prior to the shift into China in 2000 that share was less than 20%.

Thus, there is no simple answer to the question, "Is America on the Losing End of Trade with China"? It is important to recognize that the bilateral trade deficit with China is not all bad, nor all good, but consists of important trade-offs. Also, the "old" way of analyzing foreign trade with an export being a "win" and an import representing a "loss" for an economy is too simplistic nowadays since companies operate without national borders and many times are on both sides of the transaction.

None of this takes away from the Trump Administration's argument that China does not play by the same rules as others and a fairer trade policy would help both sides. However, it does raise questions over the effectiveness of tariffs as the Administration's policy tool to force China to come to the negotiating table. US companies operate with global production and sourcing platforms, many of which are based in China, so by imposing tariffs on Chinese imports may at the margin reduce the bilateral trade deficit, but at the same time hurt the cost competitiveness of US firms as they compete against other firms on the global stage. It would be a "hollow" trade victory for the Trump Administration if their tariff/trade policy lessens the trade imbalance with China but widens it with the rest of the world.

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